In 2020, corporates battened down the hatches by raising debt, cutting costs, reining in investments and generally loading their balance sheets with liquidity to see themselves through the worst.
Now, with the economy starting to fire up, inflation is quickly creeping upwards. Consumer prices rose 4.2% in the 12 months through to April, from 2.6% in March, the highest reading in over a decade.
Predictably, this is pushing up treasury yields and is liable to make corporate debt more expensive to service—which is especially concerning for companies with floating rate loans and weak earnings.
With their purchasing power under potential threat, what should companies be considering when it comes to spending their cash?
1. It’s payback time
One option is to pay back any borrowings, especially highly levered companies with more cash on hand than they've historically carried (see chart for a few notable candidates).
Given the strong hard call protections on high yield bonds and the weak soft call protections on loans, it should be expected that any repayment activity will be focused on the latter, with the exception of bonds that are nearing maturity and can be called at par.
Any corporate with a lot of cash and a lot of debt should be seriously considering this as a starting point.
2. Buy, buy, buy
Those not weighed down by liabilities have more freedom to get creative with their cash. For example, if there's one thing the pandemic has proven, it's the value of all things digital. Many companies had their weaknesses exposed, from mediocre e-commerce channels to sub-standard data strategies.
If these pain points aren't addressed, they could prove fatal. For mid-market companies that have been eyeing up a competitor that is disrupting their market or is key to their future success, excess cash could be put to work in an M&A deal rather than burning a hole in their pocket.
3. Two words: R&D
Some may choose to boost their R&D and refresh their product portfolios. The biggest spenders on innovation in the past year have been conspicuous tech names like Samsung, Alphabet, Microsoft, Intel, Huawei and Apple. Carmakers such as Volkswagen, Daimler and Toyota have been at it too, desperate to bring electric vehicles to market to fend off Tesla. Collectively, these companies invested more than US$8 billion in R&D in 2020.
Such speculative bets are not guaranteed to pay off—but if successful, they could unlock a new chapter of growth.
4. Keep investors happy—give them money
For any listed company with a share price in the doldrums, there is always the option of doling that spare cash out to shareholders. This could take the form of a special dividend or a share buyback. Critics say buybacks are a cynical ploy to bump up the share price of unloved companies. For those holding said shares, who's complaining?
5. Keep calm and carry on
And then there's the option of doing nothing whatsoever. Unemployment in the US edged up to 6.1% in April, missing economist expectations. This slack in the labor market will need to tighten before inflation bites proper.
What we're now seeing is unwarranted fear. There are likely to be supply-and-demand imbalances as significant chunks of the economy come back to life. They are causing temporary price distortions but, with the rollercoaster of the pandemic fresh in their minds, investors are easily spooked.
The smart money says the recent spike in inflation will ease off in the second half of the year. But with record stimulus still working its way through the economy, inflation will surely arrive. The only question is when.